Monday, November 30, 2009

Cash for Clunkers Contributes to the Crash

The Cash for Clunkers program demonstrated definitively that the Congress and the President don't have the foggiest idea how the economy works, including how wealth is created.

Suppose you have two countries, Country A and Country B, and both countries make Product X at the rate of one unit per year. (We're making it a really simple economy.) That means that both countries have a GNP of 1 unit of X per year. However, let us next suppose that Country A destroys every unit of X it produces when it produces a new unit of X, while Country B keeps all theirs. At the end of four years, Country B will be 4 times wealthier than Country A, even though both show the same GNP each year. (Which also shows that GNP is not the best gauge of a country's wealth.) This is how wealth is created.

With the Cash for Clunkers program, people were encouraged to bring in their old cars for a discount on a new car. This discount was made available by the government, meaning by tax money. Thus, money that could have been used elsewhere in the economy was used for this program. This is aside from all those whose salaries were paid to run the program (such a program that redistributes money does not create anything new, and therefore does not contribute to the creation of wealth in the economy -- those people's salaries are also a redistribution of money). Next, the cars that were traded in were destroyed. Thus, we acted like Country A, destroying wealth -- thus, keeping even -- rather than creating wealth. Most of the cars purchased would have been purchased anyway, either during the time of the program, or shortly thereafter, so no real effect was made on the economy. In fact, to the extent that it just moved up purchases a few months, it took away from future sales. Further, it sent false signals to the car companies that sales were up. Thus, more cars will be produced for upcoming months when people won't be buying cars, creating a surplus that will put downward pressure on prices and idle workers. Deflationary signals and the inevitable layoffs from having idle workers will send yet more signals to the economy that the recession is worsening.

Cash for Clunkers would seem like a great plan only to someone completely ignorant of how the economy works. Which of course is why Congress created it.
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